UKVI Portfolio Review – Q3 2012

The portfolio has been running now for 19 months so it’s beginning to build up a track record long enough to pay attention to. In general I would say that looking at performance over anything less than 5 years is meaningless, but of course most people just look at the last year and in this case 5 years isn’t possible as the portfolio hasn’t existed that long.

From inception in March 2011 the portfolio is up 8.9% (including reinvested dividends), which is an annualised gain of 5.5%. This compares to a total gain of 6.6% for a FTSE 100 tracking unit trust, which is 4.1% annualised. Both portfolios are based on a starting value of £50,000 and trading costs are included.

The portfolio is focused on producing a yield which is higher than the FTSE 100’s and which grows at a faster rate. The most recent yield was 4.5% and the index tracker benchmark was at 3.3%. In the last 12 months the portfolio has produced 40% more income than the index tracker, which is a pay rise I would be happy to have any day of the week.

In terms of activity, over the past three months there have been three changes to the portfolio, which follows the existing plan of having one investment enter or leave each month. I’ll get straight on and review the first of these changes.

August purchase: A FTSE 100 listed UK energy utility

The portfolio already holds SSE (Scottish & Southern Energy) so this is the second energy utility holding. The reasons for investing in this company are much the same as they are for any of the portfolio’s holdings. This company has:

A long-term growth rate of around 10% a year

A dividend yield of almost 5%, well above the market average

A long history of relatively consistent increases in sales, profits and dividends

A strong balance sheet with low levels of debt

A market leading position with strong branding and economies of scale

These are the kind of investments that I can own and still sleep well at night. There are risks of course, there are in all things –but for me this is equity investing at its least stressful.

My expectations for this holding are that not very much happens. The dividend should hopefully be raised at or above the rate of inflation, and at some point the market may look favourably on this company once again, driving the share price up to a level where it makes sense to sell.

After that I will reinvest in another out of favour, quality company and hopefully repeat the cycle of buying low and selling high once more.

September purchase: A FTSE 100 listed global leader in the mining industry

This investment is completely different to the one above, with a very cyclical rather than defensive business cycle. The mining industry is taking a bit of a beating at the minute as fears about a Chinese slowdown are everywhere, so this may be an opportunity to buy world class businesses at attractive valuations. Exactly how the commodity cycle will pan out over the next few years is as yet unknown, although there are hundreds of investment pundits who will tell you that they know the boom is over (or perhaps it’s just beginning).

In my opinion, as long as there are more people living more elaborate lifestyles across the globe, this company should do well in the long run and it’s currently priced attractively, almost regardless of whether we’re still in the expansion phase of the commodity cycle or not. This company now stands alongside BHP Billiton in the portfolio, which means I’m invested in two of the world’s biggest and best known mining companies.

The stats for this company look like this:

Long-term growth rate of more than 20% a year (although this is in the expansion phase of its business cycle)

Yield of just over 3%, making this investment a bit of an exception as it has a yield lower than the index

Strong balance sheet and market leading position

As with all new investments in the portfolio, this company was given a 1/30th weighting to start with as the goal is to hold 30 equally weighted positions.

October sale: UK Mail Group sale generates an annualised total return of almost 34%

UK Mail was added to the portfolio back in October 2011. At the time the yield was 8.6% and to my eyes the dividend looked sustainable. If that turned out to be the case then it seemed likely that the share price would be bid upwards once the dividend’s safety became more obvious. And that’s more or less what happened.

As is often the case, most of the return from this high yield investment came not from the dividend, but from the capital gains brought about as other investors piled in to get that yield.

This is an aspect of high yield investing that is often forgotten, which is why dividend investing is often seen as boring. Personally I don’t care if it’s boring, especially if it produces gains of more than 30% a year, at least occasionally.

You might ask, why am I selling now given that the yield for UK Mail is still almost 7%?

That’s a good questions and it comes down to the fact that I think it’s just as important to have a clear selling strategy as it is to have a clear buying strategy – but unfortunately most investors focus far more on buying than on selling, and that’s a mistake.

With no history of growth, the 8.6% yield was the only thing that made UK Mail attractive. Now that the yield is down to less than 7% the investment case is less compelling when compared to many other companies which yield almost as much and yet have proven themselves capable of growing over time. I would rather sell UK Mail, lock in the 34% annualised gains and move the proceeds into something else with a better combination of yield and growth potential.

Reader Interactions

Comments

Hi, I just came across your site and have found the first few articles interesting but one thing in this post confuses me a little: why do you have a plan that forces you to trade at least one equity each month?

You say that you have an “existing plan of having one investment enter or leave each month”

Doesn’t this force you to sell or buy when the share may not be ready?

Hi Lee. Yes, the once-a-month trade is a fixed part of my strategy. I’ve written about it occasionally in posts, and it’s also mentioned in the free reports that you can download, but perhaps not in very much detail, so thanks for pointing this out. I’ve just fleshed the idea out a bit more on the Investment Strategy page. It says:

“The portfolio follows a strict strategy of buying or selling one investment each month (although this is flexible, if for example two companies were taken over in a month and effectively ‘sold’). This is for a few reasons.

The first is that it allows the portfolio to be managed in a calm, methodical and proactive way, rather than reacting to whatever news happens to be coming out on any given day.

It also means that six holdings are replaced each year, which is 20% of the total. This is a relatively low amount compared to most professionally managed funds, and it helps to keep trading costs down. It also means that each investment will be held for around five years, which give each company time to grow, and keeps this strategy firmly in the realm of investing rather than speculative trading.”

I would say that when the shares are ‘ready’ is a very subjective measure. For me they are ready to be sold when they are the least attractive holding that they have, at least by my estimates. This isn’t a hard science, but you can often see cases where one stock is obviously less attractive than another. Although that doesn’t guarantee that one will perform better than the other. But on average they should, otherwise the method of measuring ‘attractiveness’ is probably not very good.

Jesse Livermore, who wrote over 70 years ago “After spending many years in Wall Street and after making and losing millions of dollars I want to tell you this: It never was my thinking that made the big money for me. It always was my sitting. Got that? My sitting tight!”

Hi John, yes I’d agree with that which is why my expected typical holding period is around 5 years. However, I’m not a buy-and-hold investor so 5 years is my interpretation of “sitting tight” rather than expecting to hold forever. Passive buy-and-hold is fine if that’s what somebody wants to do, but I think being mildly active is the best way to beat the market in the long-run.

Hi John,
I was thinking about the simplicity of your investment method and the manner in which you keep more cash as price to earnings rises. If you had started prior to 2009 i think your average returns would be smashing as i think this method will reap even greater rewards when the market crashes and you’re left with your powder dry ready to invest.

Would a logical extension of your method be to begin to take take short positions in companies as p/e ratios rise to well above average?
Shaun

Hi Shaun, that’s exactly right. I have a couple of systems for asset allocation between stocks and cash, and they do seem to reduce volatility more than returns, and so improve the risk/return trade-off over time.

As for shorting, that’s exactly what many people do, or have tried to do. I don’t have any research to hand, but generally it’s more difficult to short because of the borrowing costs involved in shorting. As you’ve said, I like to keep things simple and so for me shorting is a complicating step that I don’t think I need. However, some world-class investors like Greenblatt do use shorting, and they generally do it by reversing the buying criteria, so like you said, high PE stocks of low quality businesses is one obvious way to go.

John
It is true tha Greenblatt uses shorting but he doesn’t recommend it in his book: Value investing, from G to B and beyond.

Shorting is a very dangerous ‘bet’. I have an example of a fund manager from Artemis, who shorted Autonomy ans he was right. Unfortunately for him HP bought it at 33% premium and the poor fund manager lost all the money on that stock.

He can be consolated now that HP have realised it has overpaid 4 times, but he has lost his double ‘A’ rating ans more than half of his FUM was subject to redemption following that.

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The goal of this website is to inform and educate private investors. It does not provide financial advice or investment tips and is therefore not regulated by the Financial Conduct Authority. If you are unsure about the suitability of an investment you should consult with a regulated financial adviser. Always remember that: 1) Past performance is not necessarily a guide to future performance; 2) The value of investments and the income from them may fall as well as rise; 3) With equities you may not get back the amount of your original investment.

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